Tamer Cavusgil


Pricing is complex and generally subjective in domestic business. It is even more difficult in international business, with multiple currencies, trade barriers, additional cost considerations, and longer distribution channels. Based on a review of corporate best practices, this article proposes a set of decision rules and processes for international price setting. Specific topics for discussion include: key considerations in international pricing; the location of pricing responsibility in the multinational corporation; approaches to price setting; and transfer pricing practices.

they had to transform their pricing structures. Today. necessary increases in markups to cover rising costs and so on. trial and error and partly hard calculations by management. Factors That Affect Global Pricing Global managers readily acknowledge the critical role of prices in overseas marketing success. they can escalate to unreasonable levels because of tariffs. an increasing number of global players.. the operating environment that MNCs face is replete with complexities. since pricing interacts with and affects all other marketing policy variables. for example. Price determination is far from being scientific in the international environment.. After all. had to be adapted to the much greater heterogeneity of the international environment. originally set up to function in A single-market setting. as companies moved from purely domestic operations to exporting and then to overseas manufacturing and marketing. including competition. Yet. They can complicate a firm's marketing 61 Winter 1996 . taxes. The discussion here crystallizes this thinking and suggests a more systematic approach. • Determine the level of motivation that can be expected of intermediaries. Among other things. Pricing becomes. prices do the following: • Influence customers' perception of value. They often invite competitive reaction and. indeed. can be driven down by determined competitors. prices do have a measurable impact on sales and directly affect profitability. rapid technological change. Conversely. • Have an impact on promotional spending and strategy. Executives of internationally oriented firms must now grapple with many questions to which there are no simple or precise answers. Those structures. The purpose of this article is to review corporate practices in international price setting. in part. and • Compensate for weaknesses in other elements of the marketing mix. The globalization of marketing has put tremendous pressure on MNC pricing systems. • What is the best approach for setting prices worldwide? • Which variables should be considered in arriving at prices for foreign customers? • What level of importance should be attached to each variable? • Where in the global company should pricing decisions be made? • Should prices vary across markets? By customer types? Over time? • Should price play an active or passive role in a company's international competitive strategy? and • What factors should MNCs consider in setting transfer prices? Most executives are quick to recognize that pricing decisions cannot be nnade in isolation. Tamer Cavusgil is John William Byington Endowed Chair in Global Marketing and executive director of the Center for International Business Education and Research (CIBER) at the Eli Broad Graduate School of Management at Michigan State University.S. and highspeed communication among markets. managers have de' veloped a set of decision rules and successful approaches to setting prices for international customers and subsidiaries. perhaps for the first time. Over the past few decades.

prices are one of rhe most flexible elements of the marketing mix. e. Pricing strategies are also influenced by industry-specific factors. documentation. gives a company price flexibility. because they can usually be cbanged relatively quickly. Finally. finally asked Eord to take a controlling interest in Mazda and appointed a Eord executive as its new president (Reitman. and importing firms all face similar price escalation factors. a circumstance that reduces its pricing flexibility in its export markets. freight and insurance. a growing practice of companies is to negotiate fixed-price agreements with suppliers before making their own bids for major contracts. Consequently. Within the large constellation of factors that influence pricing for international markets. The usual reason is that the volume of their sales abroad is simply not large enough to justify foreign soutcing and manufacturing. Recently. facility never became a big factor. such as fluctuations in the price and availability of raw materials. Economic and political developments at home—and even natural disasters— can force export prices up at a time when local producers in the overseas market or exporters from third countries are not similarly affected and can keep prices low.g. demand and competition that must be considered. the Elat Rock.S. MNCs take great time and care in establishing pricing policies and setting prices for international customers. 2 Location of Production Facility A specialized product. the supply of certain needed raw materials would be reduced. those MNCs find it easier to respond to foreign exchange fluctuations. or one with a technological edge. Another problem for corporations in some industries is predatory pricing by particularly aggressive competitors. A relatively low level of price competition usually leads to administered prices and a static role for pricing in the marketing mix. As the Japanese yen appreciated significantly in the mid-90s against the U. 1996). In contrast.strategy in unforeseen ways when price variations among different markets lead to gray-market imports (Cavusgil and Sikora 1988). After registering big losses for several years. most notably those from just recently industrialized countries (NICs) in Asia. In addition to the basic factors of production cost. many companies' only participation in the global market is by exporting products they make in their home countries. producers are able to remain competitive with little adjustment in price strategy. as price competition develops and technological advantages shrink. pricing decisions for the global market must take into account variables such as exchange rate fluctuations and duties as well as external costs. In order to reduce uncertainty. In such instances a "skimming" price strategy is often used. In addition to being better able to calibrate production to local demand and competitive conditions. Mazda's exports of vehicles from Japan became prohibitively expensive. companies that manufacture abroad often enjoy greater pricing flexibility both in the countries in which they are located and in export markets. Because of the boycott. the five discussed below stand out as most important. Eventually. however. In many markets there is no local production of the item. that strategy has been pursued mainly by marketshare-hungry new players. One exatnple might be a trade embargo observed by only a few govern- ments. a company is tied to conditions prevailing in that market. Under such circumstances. dollar and most other currencies. Sumitomo Bank. government-imposed import barriers are minimal. Mazda paid a hefty price for not building production capacity outside of Japan. Mazda's only assembly plant outside of Japan. When production is kept at home. Michigan. Competitive products made in nonboycotting countries would obviously enjoy a clear price advantage in export markets. The Columbia Journal of World Business . 1 Nature of Product or Industry more and more market-based exceptions to their previously uniform pricing strategies. Mazda's chief creditor. specialized and highly technical firms must make 68 Despite the proliferation of foreignowned manufacturing facilities around the world. driving up the cost of making some products.

while an agribusiness must take into account climate. Indeed. Shift sourcing manufacturing to domestic market. and prices must be adjusted to cover those extra or special expenses. An exporter working with independent distributors. Eor instance.3 Distribution System The channels of distribution a company uses dictate much in international pricing. Bill foreign customers in the domestic currency.) in domestic market. that is sometimes a motivation for establishing a company-owned subsidiary. In contrast. The dollar's unusual strength in the first half of the 1980s. Give priority to exports to countries with relatively strong currencies.S. 69 . are a major concern to most firms. Wher) the Domestic Currency is Strong Engage in nonprice competition by improving quality. Some firms report that distributors mark up prices substantially—up to 200 percent in some countries. especially those involving large systems or technical equipment. which usually require a "full-service" intermediary in the export market. the adverse effects of successive markups can be avoided. as well as firsthand knowledge of market conditions. ginal-cost pricing to penetrate new or competitive markets. Expand product line and add more costly features. during the first half of the International Pricing Strategies Under Varying Currency Conditions When the Domestic Currency is Weak Stress price benefits. 5 Foreign Currency Differentials Pricing is affected by factors not always immediately perceived as price related. Buy needed services (advertising. In the case of sales to government agencies. led a number of companies to introduce compensating adjustments as part of their pricing strategies.S. By reducing the number of intermediaries between the manufacturer and the customer. Use of manufacturers' representatives gives a company greater price control. companies. These factors. Exploit export opportunities in all markets. including the ability to adjust prices rapidly. Winter 1996 4 Location and Environment of the Foreign Market try's infrastructure before making any bid. As one might expect. in fact. and the coun- Economic factors. but employ mar. delivery and after-sale service. many exporters are concerned about the difficulty of maintaining price levels. but this method is used less frequently by U. Speed repatriation of foreign-earned income and collections. however. Direct selling to end users is necessary in many industries. Use a full-costing approach. usually finds that it can control only the landed price {the exporter's price to the distributor). exchange rate fluctuations and price controls. Shift sourcing and manufacturing overseas. Maximize expenditures in local or hostcountry currency. Eirms often attempt to establish more direct channels of distribution for reaching their customers in overseas markets. climatic conditions in foreign markets may necessitate costly product or distribution modifications. such as inflation. Bill foreign customers in their own currency. soil conditions. dollar in foreign markets. Improve productivity and engage in vigorous cost reduaion. especially the value of the U. A maker of soft drink equipment must treat its machines intended for tropical markets to prevent rust corrosion.Trim profit margins and use marginal-cost pricing. Buy needed services abroad and pay for them in local currencies. transportation. insurance. Keep the foreign-earned income in host country: slow down collections. a protracted bidding process and negotiations preclude the use of list or other standard prices. it has greater control over final prices. Minimize expenditures in local or host-country currency. When a company is able to distribute its products through its own overseas subsidiaries. may hinder market entry and effectiveness. particularly export pricing. etc.

Companies committed to serving international markets must be creative. • Specific local cost factors. pursuing different pricing strategies during different periods. exporters enjoyed a much weaker currency. An example of a global brand priced in this manner is Grand Metropolitan's Smirnoff vodka. 70 Although global companies generally maintain centralized contrt)! over local prices. The existence of differing prices from country to country often leads to gray-market imports. Centralized pricing management by the parent company or a regional office is often the only way to prevent subsidiaries from undermining one another's pricing programs. tbey do allow subsidiaries to alter prices when vt'arranted by local conditions. the parent company wants to forecast its annual revenues worldwide. the subsidiary will be forced to follow the prices set by the market leaders. market leadership allows greater pricing freedom. Since currency fluctuations are cyclical. subsidiaries may. The Columbia Journal of World Business . There tnay be a need for a quick response to price changes made by competitors. Also important to a company's pricing policies and practices is the proximity of its overseas markets to one another. U.S. 5 Many corporations seek tight control over pricing of their "global'' brands. receive complete pricing autonomy because of competitive considerations. imposing some guidelines for the prices to be set by subsidiaries. No subsidiary can mark up the price to the point at which customers will seek to import the product rather than buy locally. in fact. it must be able to estimate the sales of all its operations. A fragmented strategy often leads to suboptimal results. i. requiring globally coordinated competitive strategies. boosting their sales in international markets. Decentraiized Pricing International pricmg decisions are centralized in most global companies. • End-user characteristics. exporting companies that find themselves blessed with a price advantage when their currency is undervalued must carry an extra burden when their currency is overvalued.e. 20% above the price of the most expensive locally produced item. at least. Appropriate strategies practiced by a broad crosssection of MNCs are presented in Exhibit 1. To create a uniform image across national boundaries. those aimed at a homogeneous market segment in many countries and positioned similarly from one market to another. not only the product. This often dictates setting prices centrally or. 2 Global companies encounter the same competitors in many markets. The price is normally set by corporate headquarters relative to the prices of competing local products in each market. Headquarters executives cite the following reasons for giving subsidiaries or distributors leeway to set local prices: • Timing. Gillette is another company that seeks "a global brand image for its products. This results in the creation of a distribution channel parallel to authorized channels but not under the control of the manufacturer in any way.1990s. In some situations. that is. but the price. Therefore. Such a policy limits local autonomy in setting prices. that the brand must always be premium priced relative to local products and that "premium" is defined as. a country subsidiary cannot set prices for its own market In isolation. Since volume planning is usually done at the corporate level. it requires centrally directed prices. must be consistent. The policy might state. the local subsidiary may have to deviate from centrally determined pricing guidelines. Valueadded taxes and the cost of adapting a product to a particular market may demand greater price flexibility in some countries. with most consumers at lower income levels. 4 Typically. • Relative market share. pricing is closely related to production-volume planning. Conversely. 1 Increasing globalization of markets requires greater uniformity of prices across markets. There are several reasons for that. say. When markets are close geographically. If the local market is relatively poor. the sourcing of a product from low-price countries by unauthorized intermediaries for sale in high-price countries. The Locus of Pricing Decisions in MNCs Centralized Pricing 3 At some companies. including its overseas subsidiaries. for example. If the brand is one of many in a local market.

sometimes referred to as tbe manufacturer's list price or manufacturer's transfer price. and • Transfer prices charged to subsidiaries. overseas distributors. promotional and finance services. Once a broad pricing strategy is set by a company's home office. Local distributors are also encouraged and given autonomy to devise their own value-added solutions. The discount structure. Winter 1996 A Delicate Balancing Act How do global corporations resolve the conflicting needs for centralization and decentralization of pricing decisions? Typically. •Economic and financial conditions. A medium-sized MNC that has adopted a decentralized price policy is the Taiwan-based personal computer firm. the extent of imionization in the transport industries and the stipulations in local distribution laws. Most global companies start out by setting a single worldwide price. Exhibit 3 presents one approach to setting prices for international customers. transfer prices charged to subsidiaries can also be adjusted to increase the subsidiaries pricing flexibility. such as targets for net revenue. Interest rates and inflation often cause local divisions to sway from corporate pricing guidelines. logistical. while tight capacity may suggest an advantage in charging higher prices. which is reviewed frequently. However. The process includes the setting t)f key prices at various levels in the channel and the factors which must be taken into account at each level. local subsidiaries receive virtually total autonomy in setting their retail prices. Transfer pricing practices are discussed later in this article. which allow them in some cases to sell the same product for different prices. an American manufacturing company's 1996 policy is that prices are not to rise more than one percent over 1995 prices.g. in Lungtan. In practice. Einally. exchange rates. subsidiaries and distributors are allowed to make adjustments locally because of the considerations listed above. if necessary. tbe degree of pricing flexibility given to the subsidiary is defined precisely. pricing freedom is transferred to local subsidiaries from headquarters through three main mechanisms: • A system of discounts on sales to intermediate customers. What is important for the manufacturer to remember is that suitability of tbe prices must be examined at several levels in the international distribu- 71 . These vary widely from country to country owing to the nature of the distribution infrastructure. • Credit arrangements and terms of sale. Exhibit 2 outlines tbe process of price determination in Kodak's inter- national distribution channels. Eor example. •Capacity utilization. consults closely with its regional and country offices to determine market conditions and formulate general market strategy and objectives. Local prices must reflect currency realities if earnings are to be eventually transferred to the home country. thus becomes a vehicle for transferring greater pricing autonomy to subsidiaries and intermediate customers. headquarters may allow local prices to deviate 5-15% from the centrally established prices. A sequence of key tasks are identified. market share and the growth rate for gross sales. depending on the nature of the total package. The home office. there is no single approach to international pricing that is best for every company and every situation. The company adopted this policy in an attempt to fend off its chief rival. the corporate office sets policy and issues general guidelines to which the overseas subsidiaries and distributors must adhere. Acer's marketing and sales headquarters in Taiwan provides technical.. landing costs etc. In some companies. Similarly. Approaches to Price Setting Clearly.•Transportation costs. The guidelines are usually written at the beginning of each fiscal year—or more often. Tbe discount rate varies for different customers and territories on tbe basis of competitive considerations. Pricing policies reflect both the general direction prices should take during the course of the year and the company's underlying global strategy. A subsidiary with excess capacity in a local market may choose to lower prices to boost demand. on the basis of the above objectives as well as cost information provided by Lungtan. credit terms and other variable conditions of sale have a direct impact on the final cost to subsidiaries and intermediate customers. the effective price or the price charged to intermediate customers (e. or subsidiary) is determined by a discount system. Acer. Eor instance. However. The company as a whole benefits as a result of a pricing system that is responsive to local needs.

sets floor prices at headquarters after considering costs.g. insurance. wholesalers. availability.Setting of Prices at Various Levels in the International Distribution Channel: Kodak Example Key Steps in Price Setting Manufacturer's Transfer Price Relevant Considerations Source of supply. skimming vs. distributor push. company policies (such as whether or not to factor in domestic overhead). the Japanese computer peripherals manufacturer. exchange rates Factory Billing Pnce Distributor Gross Margin Competitive considerations. incentives and support provided by distributor. marketing strategy {e. recommendations The Columbia Journal of World Business . subsidiary).. competitive intensity. customs. tax rates. distribution. debt. gray market considerations.g. balance of payments." which is the lowest possible price at which the product may be retailed or wholesaled {depending on the nature of the company). repatriation of earnings difficulties Discount Factor (01) Relative importance of market. marketing and administrative overhead. aggressiveness.. Costs typically include R&D. raw materials.g. etc. the process is complicated because of differences in cost accounting practices.. and so on. global manufacturing and sourcing factors. Exchange Rate Adjustment Inflation rate. penetration). duty. processing. taxes. At most companies a product's price starts with a "floor price. loss leader pricing) Value Added Tax Type of product. government policy Retaii Price tion channel—the importer. As the following examples suggest. negotiations. nature of customer (distributor vs. costs. and so on.. retailers. government policy Distributor's Exit Price (List Price) Value Added Tax Type of product. Arriving at the correct floor price is not as easy as it seems. size of customer. volume and share objectives. transportation. competitive considerations. productline considerations (e. aggressiveness. produrt-line considerations. pricing strategy (e. support and incentives provided to retailers Local Costs X Freight. consumer pull vs. government policy Retailer's Mark-up Going rate. The floor price is derived from the total cost of bringing the 72 product to market plus a corporate markup. • Seiko Epson. profit taking vs. market-oriented pricing).

• Hewlett-Packard leaves tbe responsibility for setting floor prices ("factory base prices"). distribution prices. In arriving at tbe discount structure for its dealers. customers. wbicb tend to be at the higb end of tbe range in each product category.MNC takes into account tbe excbange rate. ceiling. while tbe prices charged for higb-end products like computers and laser-jet printers can range from 10 percent to 25 per73 . freight. to the product divisions. and end users prices Monitor market performance and make adjustments as necessary from executives in tbe company's various manufacturing divisions and country markets and a corporate profit markup target for the particular product. a currency differential (premium) is added when necessary. and expected prices Assess company sales potential at given prices Examine corporate goals and preference for pricing strategy Select suitable pricing strategy: •Rigid cost-plus •Flexible cost-plus •Dynamic incremental Check consistency with current price setting across product lines. tbis sort of price flexibility is considered essential by marketing staff.S. manufacturing company sets the same list price (fob factory) in tbe U. and markets Implementation: Select tactics. Salespeople in beadquarters are allowed to negotiate prices within tbese parameters witb country-level sales affiliates. etc. Final prices. and abroad. but that is no longer the case. technical support and a comprehensive warranty. local competition and a reasonable profit margin for tbe dealers. Starting from tbis figure. Estimate target price range for end users Estimate floor.Exhibit 3 A Decision Making Framework for International Pricing Estimate the price of the product "landed" in the foreign market by considering international customer costs (documentation. Low-end products-such as Epson's LQ-500 series printer-are usually restricted to a variability range of less tban 5 percent. because of the development of overseas production facilities and sourcing. product division presidents at beadquarters establish flexibility parameWinter 1996 ters. In tbe past. whicb are derived from production costs. • One U.S. Management tben assesses tbe competition in major markets and builds an appropriate profit premium into tbe price.) Estimate the price the importer/distributor will charge by considering tariffs and intermediary profits cent above or below tbe base price. In calculating floor prices. factory base prices coincided witb U. insurance. tbis industrial manufacturing . also reflect sucb elements of the company's strengths as service. prices. In view of the rapid technological change and rapid entry of new products in tbat industry.S.

documentation and customs charges as well as profit margins for botb tbe distributor and the manufacturer. Japanese and Korean MNCs in particular have successfully used penetration strategies in tbe U. 3 Dynamic incremental pricing.S. discounts may be applied to the final price. The Columbia Journal of World Business . depending on the customer." price is the lowest possible. offering them low prices when it bas a sufficient quantity of the product. in "skimming" a company introduces the product into a market at a relatively bigh price. and other Western markets. packaging. perhaps enlarging its market share. a formula tbat ensures margins but may pusb the final price so high tbat the company becomes uncompetitive lu major markets. industrial MNC negotiates "onc-sbot" deals witb its distributors. one U.S. It. bighly visible advertising and extensive media coverage. when tbe sales potential is good or when competitive pressure necessitates aggressive pricing. This approach enables the company to sell its exports at very competitive prices. also known as "penetration" pricing. bigb-tech items. too. Tbe complexity of export pricing bas caused many managers to cling to rigid cost-plus pricing. Most companies tbat use dynamic incremental pricing do so only under special circumstances. Dynamic incremental pricing also implies skimming when it coincides witb a dominant market share posirion. When carried to extremes. often while limiting distribution. since it cannot be cbanged to any significant extent. For example. In some cases. transportation. the Middle East and tbe Far East to about 70 percent of its previous price. Cost-plus pricing is a static element of tbe marketing mix. or "market floor. This strategy was successful in limiting tbe inroads made by tbe company's Japanese competition. For example. the primary objective of tbis approacb is still to maintain profit margins. tbat are in effect in many countries. 2 Flexible cost-plus pricing. as when a company charges a price lower than the cost of making the product or the product's domestic price. the size of tbe otder or tbe strength of local competition. insurance. A certain segment of tbe market will pay premium prices to be first to have such things. prices tend to increase slowly. such as advanced consumer electronics devices or trendy products. however. Several years ago. This strategy sets list prices in tbe same way as tbe more rigid system but allows for price variations in special circumstances. Under this strategy. is thus an essentially static element of the marketing mix. which are usually introduced amid great excitement. Tbe objective is to gain as much market share as possible in tbe shortest time. penetration pricing may run afoul of local antidumping laws. This can be an effective method for launching innovative. Once tbe product attains a sufficient market share. dynamic incremental pricing helps a company introduce a product to a market. As with a penetration strategy. as other companies cannot afford to ignore the price leader's practices. Whereas in penetration strategies introductory prices start low and slowly rise. Over tbe past few decades. Tbe foreign list price is set by adding international customer costs and a gross margin to domestic manufacturing costs. Tberefore. Cummins Engine reduced its engine prices dramatically in Europe. it seeks to recover only 74 variable and international customer costs in export prices while adding in a partial overhead factor rather than the full overhead load. often inviting dumping charges by local marketers. Although there is more room to adapt export prices to local conditions. This method assumes tbat fixed costs are incurred regardless of tbe company's export sales performance. the introductory.Options in Export Pricing Companies have three basic options in setting prices on exports (Cavusgil 198S): 1 Rigid cost-plus pricing. The final price to tbe foreign customer includes administrative and R&D overhead costs. tbe price slowly comes into line witb tbe product's price in other countries. marketing.

however. Market prices can be adjusted to reflect specific characteristics of the goods or services involved. To equitably sbare tbe advantage of lower costs. Products can be sold to Winter 1996 members of the same corporate family at cost or a variation of direct cost. MNCs typically centralize transfer pricing under the direction of tbe cbief financial officer. Among the modifications available are variable costs (tbose costs of materials. and transfer pricing may be the only means of getting earnings out of the country.Transfer Pricing Practices One of the thorniest problems global companies grapple with wben they venture beyond tbeir bome-country borders is transfer pricing (also known as "'intracompany pricing"). unless some taxable profits are allocated to the supplying unit. A disadvantage of the method is that it leaves tbe cost centers witb little inducement to make investments. transfer prices must be lower tban market price. marketing and finance equally well. For example. Some global corporations use different transfer pricing metbods for different purposes. tbe company as a whole can achieve optimal results by means of careful transfer pricing. including the benefit of any cost reductions due to global efficiencies. Another problem is that tax authorities generally do not accept this technique. marginal costs [the costs of producing one more unit) and full absorption costs (costs that would not change if sales to other business units stopped—for example tbe cost of shared factory overhead). First. transfer pricing can become a vehicle for repatriating profits from tbose countries that have remittance controls. Global companies attempt to manage tbeir corporate families' internal prices primarily for two reasons. From a performance evaluation perspective. unlike actual cost. Others opt for tbe simplicity of a single approach. Companies tbat expect to have unused capacity for a time often lower their transfer prices in order to provide incremental contributions to tbe coverage of "sunk" costs. Underlying both objectives is the desire to foster corporationwide efficiency. Because this approach removes internal bias and facilitates validation. The following are among tbe possible alternatives. they may be reduced to reflect lower marketing or distribution costs tbat occur in external markets.. For this reason. leading to additional inefficiencies for the company as a whole. Second. funds may be blocked by tbe central bank. such as tax authorities. it appeals to outside parties. transfer pricing can be a way to shift profits out of hightax countries and into low-tax ones. in which variations from standard cost signal tbe need for additional investigation and attention by management. There has never been a single "best" way to set transfer prices. It also facilitates "management by exception" decisionmaking. Prevailing external market prices (arm's-length prices) are often viewed as the best transfer pricing mechanism for external reporting. has the advantage of identifying efficiencies or inefficiencies in the supplying unit. • Standard cost. at inflated prices or at some combination of tbese. • Modified market price. market prices may be unfair because they give the supplying business unit the entire profit on the transaction. • Actual cost. A major sbortcoming is tbat standard costing often requires management to make arbitrary assumptions and leaves the company vulnerable to expending time unproductively in debates on how to set tbe standards. Nor does any system meet all tbe needs of production. The prices at wbich units of the same company sell to each other bave a farreaching effect on the company's success because they influence everything from foreign subsidiary performance to executive compensation to tax obligations. accepting the cost and complexity of maintaining more than one system. wbich is sometimes viewed as the absence of a transfer price. actual or standard costs arc sometimes adjusted to encourage more extensive use of certain products or services. an approach that resolves many internal disputes over allocation of profits. In the extreme case. labor and overbead that vary directly with the number of units produced). • Market price. accepting the inevitable deficiencies of whatever system they choose. Companies have available a number of transfer pricing strategies available. one that satisfies both tbe parent company and its foreign affiliates (not to mention the tax collectors in all countries concerned). While individual units may sbow poor performance. For example. at market prices. Manufacturing facilities are treated as cost centers rather than profit centers. 75 . • Modified cost is useful in promoting acbicvement of strategic objectives. Ordinarily. can be used for intracompany transactions.

keeping transfer prices low can reduce local valueadded taxes. In sucb a case. Perhaps the most significant concerns in setting transfer prices are the local tax rate and pertinent tax regulations. especially if there are restrictions on repatriation of profits. Similarly. the decision involves some combination of tbe considerations discussed below: • Local taxes. • Expense accounting. When government imposes local price controls. As a result. This lowers overall taxes when the assets are transferred from lower. • Currency fluctuations. are provided to the subsidiary but cannot be charged because of restrictions. such as product development or strategic planning assistance. wbicb could result in counterproductive and expensive procurement of goods and services from outside the firm. whicb can be provided in tbe form of lower purcbase prices from or higher sales prices to other company units. Similarly. Still another use of transfer pricing is to manipulate the profit position of a subsidiary. transfer pricing practices may again help. In tbat case. However. • Joint venture support. a market niche can be carved out more quickly for tbe startup and its long-term survival guaranteed. For most companies. An effective transfer pricing system sbould deal with changes in import-export duties. income taxes. startups often require substantial corporate assistance. lower transfer prices mean lower levies. In this way. One drawback of the method is that it does not pass on price bikes in raw materials to marketing units. etc. • Contract price. Generally. The use of transfer pricing to sbift profits into local jurisdictions tbat have relatively lower corporate tax rates normally results in lower overall income taxes. prices in excess of certain thresholds may result in higher import duties. costs for those services can be recouped by increasing the transfer prices of components sold to the units. clearly dictating a particular pricing system. a company's situation is mixed. higb prices for capital assets increase tbe depreciation allowances for the business units that receive them. negotiators may fail to reach agreement. Such a "contract" price eliminates variations that result from centralized sourcing decisions beyond tbe control of managers of foreign operations. a supplying unit that has no excess capacity will still feel unfairly penalized if the lower price cuts into tbe profits the unit would otberwise earn on external sales. making the choice highly complex and probably contentious. Higher transfer prices on exports of intermediate The Columbia Journal of World Business . Transfer prices can also be used to advantage wben tbe host government poses restrictions on allowable deductions for expenses. excise taxes. Sometimes one issue is of overriding importance to a company. Sometimes certain services. A variation of the negotiated price method is a price agreed upon at the time the firm's business plan is adopted. • Negotiated prices are determined by bargaining between the buying and selling units.this will help resolve perceived inequities among supplying and receiving business units. especially if they are assessed on an ad valorem basis.to higher-rate jurisdictions. Lowering the prices of products and services to a parent reduces the outflow of funds from the home country. transfer pricing can help recoup expenses from a joint venture.. while raising the prices of purchases from the parent shifts funds to the home country. Although some executives may argue that this technique results in an arm's length transaction that is just as valid as an external market price. tbe external profit is a relevant opportunity cost and it should be factored into the transfer price. For instance. Another problem is that excessive internal competition can undermine the achievement of congruent goals among business units and result in a serious loss of cooperation. However. For example. in a way that minimizes these taxes overall. VATs are based on the value added within tbe taxing jurisdiction and are factored into the price at the next sales level. More often. its use in evaluating the performance of subsidiaries has some risks. it removes the marketing unit's incentive to recover any inflationary and foreign excbange losses through third party pricing. How do global companies choose among these transfer pricing possibili76 ties? Many factors are involved in deciding wbicb transfer price to use and wbether to use different prices for reporting external and internal performance. • Subsidiary profits. Transfer prices can be adjusted so as to balance the effect of fluctuating currencies when one subsidiary operates in an environment of low-level inflation and another in a climate of rampant inflation. however.

g. pricing will continue to gain significance for global companies over the next decade. quicker response to marketplace changes. Tbose companies tbat operate in so called global industries. Witb intensified competition and interdependence of markets. As implied by the above discussion. because of cultural differences. tbere is tbe complication . in many countries. These challenges imply new or improved practices on the part of global companies. morale problems typically surface at a subsidiary whose profit performance bas been made worse artificially. For example. • Output capacity. Nevertbeless. there is the concern over local regulations. transfer pricing practices are often subject to close review by local authorities. as local businesses. Fourth. achievement of the delicate balance between corporate and local control of prices. tbe ability to control internal prices cbarged to subsidiaries affords the global corporation significant flexibility and overall efficiency. First. In tbis illustration. Tbe corporate reasons for this are also outlined. Manipulating transfer prices makes it very difficult to determine the true profit contribution of a subsidiary. avoidance of graymarket or parallel-importing activity and development of alternatives to often costly price competition. must abide by the rules.How Transfer Pricing Can Help Maximize Corporation-wide Reported Earnings Sells cost plus Subsidiary A is likely to be in a country that has: • Low corporate income tax • Higb tariffs • Favorable accounting rules for calculating income (e. Subsidiary A is considered a "favored" subsidiary since it is allowed to source at a low cost and sell at a high price when transacting with other subsidiaries. Legal problems will arise if tbe subsidiary follows accounting standards that are not approved by tbe host government. Tbird. smooth and rapid system of communication with subsidiary managers or distributors is essential. Subsidiaries. allowable deductions) • Political stability • Little or no restrictions on profit repatriation • Strategic importance to company of internal control measures. global managers will find management of prices even more cballenging. Second. The challenges will involve attainment of better coordination of worldwide prices by corporate headquarters. these benefits often come at a cost. Conclusion Undoubtedly. some subsidiary management's may react negatively to price manipulation. sucb as tele77 goods from a parent to a subsidiary in sucb a market may help support the case for an increase in tbe price of tbe final product. Indeed. Subsidiaries with substantial excess production capacity can set transfer prices low enough to encourage additional internal consumption but high enough to cover tbe supplying unit's variable costs. an efficient. Exhibit 4 illustrates graphically tbe dynamics of transfer pricing among tbe members of tbe corporate Winterl996 family.

S. Increasingly. 3 (May-June 19881:54-63. Acknowledgment: This article is based partially on the author's earlier work which appeared in a corporate report. 15 April. Cavusgil. "How Multinacianals Can Counter Cray Market Imports." Columbia Juurnal of World Business 23. No. Marketing Strategies for Global Growth and Competitiveness. 4 (Winter 1988). Pricing globally also remains an organizational cballenge. or medical equipment. Pricing executives will also bave to develop a better appreciation of tbe intimate relationships between price and other elements of the marketing mix. construction equipment. . 75-86. No. Price represents only one item in the bundle of benefits perceived by the customer. after-sale service.Mazda. many companies make critical pricing decisions without the necessary consultation with all units concerned.57-70." Wall Street Journal.' Business Horizons 31. credit terms and so on. follow-up sales opportunities. Interpreting customer's perception of product value continues to be a formidable bur necessary task. 1990. Pricing decisions cannot be reacbed in isolation from otber dimensions of the offer. Nevertheless. "Japan is Aghast as Foreigner Takes rhe Wheel at . Valeric (1996]. "LInraveling the Mystique of Export Pricing. NY: Business International Corporation. Pricing decisions tbat are based on a good understanding of perceived value-— from the perspective of both the intermediaries and the final customers—are more likely to be successful. need to devise efficient mechanisms for monitoring competition worldwide and disseminating relevant information to the members of tbe corporate family in a timely manner.communications. S. Tamer and Ed Sikora (1988). References Cavusgil. Reirmaii. 78 The Columbia Journal of World Business . it is an area in which input from different functional divisions and regions allows for better decisionmaking. such as product quality. New York. Tamer (i9S8}.

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